Market demand and

elasticity
31 August 2022
Review Questions
1. Define and graphically derive the Engel Curve.
2. Use appropriate diagrams to derive a consumer’s individual
demand curve.
3. Explain the income and substitution effects of a price change.
4. Distinguish between an inferior good and a Giffen good.
5. Explain the income, substitution and total effects of a price
decrease for:
a) A normal good
b) An inferior good
c) A Giffen good
From Individual to Market Demand
• Once we know the individual demand curves for several
consumers, we can use them to construct the market demand?
• To construct the market demand curve for burgers for example,
the quantities demanded by each buyer are simply added up at
each price.
• The market demand curve shows the quantity of a good (per
unit of time) that is demanded by all the consumers in the
market, at each possible price, holding money income & prices
of other goods constant.
From Individual to Market Demand
• The market demand for any good is therefore the horizontal
summation of the individual curves for all the consumers in the
market.
• The horizontal summation of individual demand curves implies
that individual quantities at each price are added up to obtain
the market quantity demanded at that price.
Example:
Suppose that only three students Kabo, Tshepo and Neo like to
buy burgers at the UB cafeteria and the demand curves for each
individuals are as follows:
Kabo: Qd = 50 – Pd.
Tshepo: Qd = 60 – Pd.
Neo: Qd = 80 – Pd
The Market Demand schedule and the Market Demand curve can be derived as follows:
Quantity per month

Price/burger (P) Kabo Tshepo Neo Market Demand

0 50 60 80 190
10 40 50 70 160
20 30 40 60 130
30 20 30 50 100
40 10 20 40 70
50 0 10 30 40
ELASTICITIES OF DEMAND
Elasticity of demand refers to the responsiveness of market
demand for a commodity to changes in its own price; changes in
income and changes in the prices of other goods.
Price Elasticity of Demand (PED)

The PED at each point on the market demand curve is

defined as the percentage change in the quantity demanded
resulting from a 1% change in price.

It measures the responsiveness/sensitivity of quantity

demanded of a good to changes in price, other things equal.
 ∆𝐐 ∆𝐏
= . 𝟏𝟎𝟎% ÷ . 𝟏𝟎𝟎%
𝐐 𝐏

∆𝐐 𝐏
= .
𝐐 ∆𝐏
Rearranging terms,
∆𝐐 𝐏
𝛆𝐝 = .
∆𝐏 𝐐

∆P 𝟏 𝐏
NB: slope = therefore 𝛆𝐝 = .
∆Q 𝐬𝐥𝐨𝐩𝐞 𝐐
There are two ways of calculating PED.

1. Point-price elasticity of demand

It measures elasticity at a specific point of the demand curve.
Usually applied for small changes in the price.

∆𝑸 𝑷
𝜺𝒅 = .
∆𝑷 𝑸
2. Arc/ mid-point elasticity of demand
It measures elasticity between 2 points on the demand curve.
Usually applied for large changes in the price.

∆𝑸 (𝑷𝟏+𝑷𝟐)/𝟐 ∆𝑸 𝑷𝒂𝒗
𝜺𝒅 = . = .
∆𝑷 (𝑸𝟏+𝑸𝟐)/𝟐 ∆𝑷 𝑸𝒂𝒗
It is important to distinguish between own-price
elasticity of demand and cross-price elasticity of
demand.

Own-price elasticity of demand measures the

responsiveness of the quantity demanded of a good to
changes in its own price, other things equal.
For a commodity X, own-price elasticity of demand is
written as:
𝒅𝑸𝑿 𝑷𝑿
𝜺𝑿 = .
𝒅𝑷𝑿 𝑸𝑿
Cross-price elasticity of demand measures the
responsiveness of the quantity demanded of a good, say
X to changes in the price of another good, say Y.

Suppose we have 2 goods, X & Y. Then the cross price elasticity

of demand is:
𝒅𝑸𝑿 𝑷𝒀
𝜺𝑿, 𝒀 = .
𝒅𝑷𝒀 𝑸𝑿
→the change in quantity of X due to a change in the price of Y.

How would we express the change in the quantity of Y due to a

change in the price of X?
An Analogy

• A piece of concrete is not able to be stretched. Therefore, it can

be described as being inelastic. In other words, as a force is
applied (change in price), there is little change in length
(quantity).

• A rubber band can be stretched by applying a force. Therefore,

the rubber is described as elastic. In other words, as a force is
applied (change in price), there is an observable change in
length (quantity).
Interpreting PED
The value of PED will be a negative number due to the inverse relation
between price and quantity demanded, however for convenience, we drop
the negative sign and use the absolute value.

Therefore we say, PED ranges between zero and infinity i.e. 𝟎 < 𝜺𝒅 < ∞

Case 1: 𝟎 < 𝜺𝒅 < 𝟏

• Here demand is said to be relatively inelastic.
• This means that a given percentage change in price leads to a smaller
percentage change in the quantity demanded.
Case 2: 𝜺𝒅 = 𝟏
• Here demand is said to be unit elastic.
• This means that a given percentage change in price leads to exactly the
same percentage change in the quantity demanded.

Case 3: 1< 𝜺𝒅 < ∞

• Here demand is said to be relatively elastic.
• This means that a given percentage change in price leads to a larger
percentage change in the quantity demanded.
Special cases of PED
Case 4: 𝜺𝒅 = 𝟎
Here demand is said to be perfectly inelastic.
• This means that any given percentage change in price leads to no change
in the quantity demanded. i.e. even the largest increases in price will not
cause consumers to switch to substitutes.
• Graphically, it is represented by a vertical demand curve.

P D (Єd=0)

Q
Case 5: 𝜺𝒅 = ∞
• Here demand is said to be perfectly elastic.
• This means that an infinitely small change in price leads to an infinitely
larger change in the quantity demanded. i.e. even a very small change in
price will cause consumers to ditch the product in favour of substitutes.
• Graphically, it is represented by a vertical demand curve.
P

D (Єd=∞)

Q
Determinants of PED
1. Availability of close substitutes in consumption
• If a good has many close substitutes, then its demand is more likely to be price elastic.

2. The nature of the good (luxuries vs necessities)

• Luxury goods tend to have a more price elastic demand than necessities.

3. Budget share
• The greater the proportion of income spent on the good, the more price elastic its demand will be.
• E.g. the demand for paper clips or salt may be inelastic because the typically consumer only spends
a small fraction of his income on such goods.

4. Time period/frame
• Demand is more likely to be price elastic in the long run than in the short run.
• This is because consumers take time to adjust their consumption patterns i.e. the longer the time
period, the easier it is for consumers to substitute one good for another.
Example 1
Given the demand function as: Q=30-2P, where P=P10, calculate
and interpret the PED.

Step 1: Define PED

𝑑𝑄 𝑃
𝜀= .
𝑑𝑃 𝑄
Step 2: Solve for Q, substitute P=10 into the demand function.
Q=30-2P
=30-2(10)
= 10

Step 3: Substitute into the formula

𝑑𝑄 𝑃
𝜀= .
𝑑𝑃 𝑄
10
= −2. = −2
10
𝜀 = −2 = 2
Since 𝜀 > 1→ demand is elastic.
Example 2
Suppose that during a Zebras match at Gaborone Stadium, you decide
to set up a stall and sell drinks. The price for a can of coke is P20, at
which 80 cans of coke were sold.
Given the linear demand curve below, calculate the point elasticity of
demand for coke.
Price

60

20 •A
D
0
80 120 Q
Recall that point elasticity of demand is given as:

Substitute into the formula:

Interpretation?
Review Questions
Question 1
Now suppose that there is a second Zebras match at the stadium. You
decided to also sell peanuts at P30 per packet. At this price, you sell 60
packets of peanuts.
Assuming the demand for peanuts as the same slope as the demand for
coke, calculate and interpret the point elasticity of demand.

Question 2
There is one more Zebras game at the stadium. This time, you decide
to also sell some hot dogs at P40 each. At this price, you sell 40 hot
dogs.
Assuming the demand for peanuts as the same slope as the demand
for coke, calculate and interpret the point elasticity of demand.